July 2018 Comments: Tariffs

In a recent front page article on tariffs (6/20/18), the NY Times wrote in its lead paragraph, “President Trump’s threat to impose tariffs on almost every Chinese product that comes into the US intensified the possibility of a damaging trade war, sending stock prices tumbling yesterday and drawing a rebuke from retailers, tech companies and manufacturers.” For the record, the S&P 500 index closed June 19th at 2,762, down from 2,773 (less than half of one percent for the day), and closed Friday, August 3rd at 2,840, up almost 3% from its June 19th close.

As regular readers of these Comments know, Park Piedmont is almost always skeptical of the media’s efforts to overstate market moves, and to attribute single causes to market changes driven by many factors. Nevertheless, it is worth having a basic understanding of tariffs, some of their effects on economies, and their potential impacts on financial markets.

Tariffs are a tax, mostly on goods, that are imported from another country. If the US puts a 25% tariff on steel coming into the US from China, it is making that steel more expensive. The expected impact is to raise the price of imported steel in the US, thereby reducing American demand for this steel and making steel manufactured in the US more competitively priced. At first blush, it is clear that the US manufacturer of steel is benefitted, and the Chinese manufacturer is hurt. But it should also be clear that the higher price for steel should likely increase prices for US goods made with that steel, so some other business/businesses in the supply chain, and/or the end consumer in the US, is likely to pay more for the goods made from steel.

In a recent article on tariffs (NY Times, 6/16/18, page A8), Neil Irwin provided his insights on the current tariff situation, focusing on the US-China trade relationship. “The US moved forward Friday with a 25% tariff on $50 billion of Chinese imports, adding to tariffs imposed in previous weeks…. For many years, American companies have complained of being treated shabbily as they try to do business in China. They often must partner with Chinese companies to be allowed to do business in the country, and frequently complain that their most advanced technologies are being stolen, among other concerns. The Trump administration’s list of goods to be subjected to the tariffs is aimed at these high tech sectors…. In return, China said it will place tariffs on $50 billion worth of American imports.”

Irwin continues: “China views the development of its high-tech industries as core to its economic strategy of the future and won’t want to give up advantages in these sectors lightly. On the other hand, the substantial US trade deficit with China means America has more potential Chinese imports on which to slap punitive tariffs.” Irwin then explains that the US and China almost had an agreement on China buying more agriculture and energy products from the US, which would have reduced the trade deficit, but not helped with the longer term issues around technology.

Irwin’s article then turns to the current impact on the US economy by noting that “the US has a gross domestic product (GDP) of nearly $20 trillion, so a new tax on $50 billion (or eventually $150 billion or more) of Chinese imports is a rounding error…. As countries retaliate (with their own tariffs) they can certainly cause damage for individual American industries that export, but the reality is most economic activity in the US is for domestic consumption. Exports constitute about 12% of GDP.” Soybeans, a product heavily exported to China, is cited as an industry adversely affected, along with “some major industries that use steel and aluminum heavily [and] are complaining of sharply higher prices, which make them less competitive against global competitors.”

The article continues: “the risk comes if things spiral out of control in ways that crater the stock market or lead businesses to pull back significantly on their investment spending…. The initial tariffs on Chinese goods are not focused on consumer products, but on products mainly purchased by businesses … which could put upward pressure on inflation…. Even if the dispute spreads to consumer goods, the actual amount American consumers will pay depends on many factors, including the availability of domestic substitutes and the competitiveness of the industry. For any given product it is hard to predict how much of the tariff will be passed through to the consumer versus absorbed by producers and retailers.”

Other articles on tariffs discuss the impact on supply chains. An example from Bloomberg Businessweek (4/16/18, page 11): “It is well understood that tariffs on imported goods raise prices for domestic businesses and consumers…. What is less familiar is that tariffs are blunt instruments that strike every nation in a supply chain, not just the ones being targeted…. Globalization almost guarantees casualties from friendly fire. The US tariffs on steel and aluminum will have impacts on eight or nine mostly developing countries from which China buys iron ore for its steel production.” Many other examples of the impact on countries in the supply chain of the products being subject to the tariffs are presented.

At Park Piedmont, we view the tariff issue as one of many factors that affect the economy and the financial markets, with highly uncertain impacts going forward. As always, we suggest maintaining previously established appropriate allocations of liquid investment portfolios, even when the media attempts to isolate particular issues as major negatives.